Magazine

Commentary: Why Health Savings Accounts May Flop

March 14, 2004

It's that time of year: Accountants are reminding you to make contributions to tax-favored plans such as IRAs and 401(k)s. This year brings a new option -- the Health Savings Account, approved late last year in the same bill that gave seniors prescription-drug coverage. But don't rush to sign up: You almost certainly don't qualify.

In fact, fewer than 0.5% of the 125 million to 150 million Americans covered by health insurance at work can participate. Why? They don't have the high-deductible plans required as a condition for contributing. For a single person, the deductible must be $1,000 or higher; it's $2,000 or more for a family. Each year, you and/or your employer together can save enough to cover your deductible (up to a maximum $2,600 for an individual or $5,150 for a family). The money goes in before taxes, grows tax-free, and is never taxed if it's used for qualified expenses. Unused money rolls over to the next year and goes with you when you leave.

In the near term, the market for HSAs will remain small. The law was enacted too late for most companies to roll out such plans for 2004. But Edward Kaplan at Segal Co., a national benefits-consulting firm, predicts only a million more employees and their dependents will join the HSA-eligible in 2005.

Employers, desperate to rein in spiraling costs, would love to offer insurance with big deductibles. But unless they're willing to kick in generously to the HSAs, employees are likely to see this as simply a way to hack off front-end coverage. People who got used to $10 and $20 co-pays under managed care are unlikely to welcome a plan that sticks them with the first $2,000 of their health costs. Of course, if the labor market remains soft, workers may eventually have no choice.

While some healthy employees might value the opportunity to sock away pretax money for future medical expenses, the HSA carrot of building your own health fund won't be enough. Ed Pudlowski, senior manager of health benefits at accounting and consulting firm Ernst & Young, points out that health costs have been growing faster than investment returns. So any money set aside to pay future medical bills won't keep up. A perennially healthy 40-year-old might manage to roll over $1,000 of his HSA contribution every year. He would have $46,000 when he retired at age 62, assuming the money earned 6% annually. But if costs continue to rise about 10%, that won't even be enough to pay a year's worth of medical bills for the average 62-year-old. Those who think they'll use the kitty to pay premiums after retirement will also be disappointed -- you can't use the money to buy Medigap insurance.

The idea behind the HSA is reasonable: Hold down medical costs by encouraging workers to spend more wisely. But it will be up to employers to sell this one. Without their largesse, to most workers, HSAs will simply look like stingier coverage. By Carol Marie Cropper